Kuwait’s central bank expects the country’s economic growth to slow dramatically this year as it predicts a contraction in the contribution of the oil sector, as the crude exporter trims output. The central bank forecasts real economic growth of 1.9 per cent this year, compared with 6.3 per cent in 2012 and 8.2 per cent the year earlier.That is below the forecasts of both Citigroup and National Bank of Kuwait but in line with International Monetary Fund estimates. Kuwait’s economy has suffered as political wrangling and government bureaucracy have delayed key infrastructure projects and reforms.

Despite its oil riches, the country – which has an elected parliament with powers to question the prime minister – has struggled to kick-start the economy. “These are testing times for financial institutions across the globe,” Mohammad Al-Hashel, the central bank governor, said. “The banking sector in Kuwait is continuously developing its operations and activities in order to meet the challenges that followed the economic and financial crisis in 2008.”

Banks are facing slower economic growth in Kuwait as oil GDP is set to decline in the Gulf monarchy, which saw some of the largest protests in its history last year. In line with the IMF, the central bank predicts that oil GDP will shrink 3.4 per cent in 2013 compared with growth of 8.4 per cent in 2012. Importantly, the contraction is attributed to a tapering of oil output as opposed to a price decline, the central bank confirmed. “In terms of the deceleration in the headline growth rate – it’s an oil story,” says Daniel Kaye, head of macroeconomic research at the National Bank of Kuwait. Gulf countries including Kuwait may take the opportunity to trim their output in light of historically high production, he adds.

Global demand and price will also play a key role. Kuwait’s oil production reached 3m barrels a day at the end of last year, close to its theoretical maximum of about 3.1m or 3.2m, but they prefer to “keep a bit of a margin for spare capacity”, adds Kaye. But what economists will be paying closer attention to is the non-oil economy, a better indicator of how the broader economy is performing. For Kuwait, which has lagged behind its Gulf peers in diversifying its economy away from oil, the central bank forecasts non-oil GDP growth to remain steady at 5.3 per cent this year, from 5.1 per cent last year. Despite its vast oil wealth, Kuwait has struggled to get its key infrastructure projects off the ground. Economists are now watching two projects in particular – the Az Zour North power plant and the Sheikh Jaber al-Ahmad Al-Sabah causeway.

A consortium led by GDF Suez won a contract to build the Az Zour North Independent Water & Power Project in January but economists are now pointing to another potential hold-up in parliament. Solid progress on either would provide encouragement that spending plans were under way. Political disputes between the most powerful parliament in the Gulf and the government have contributed to the slowdown in spending but since the opposition boycott of the last elections, the new pro-government parliament is expected to facilitate progress on the country’s long-awaited projects.

Other measures to boost the economy such as slashing interest rates have little impact in a country such as Kuwait where banks have few opportunities to lend. Mr Hashel told the FT that the current level of the discount rate – the rate which banks are charged to borrow short-term from the central bank – at 2 per cent was “appropriate at this time”. The central bank cut the rate on October 4 to “enhance the conditions that support economic growth while maintaining attractiveness and competitiveness of the national currency as a store for local savings”.

He adds that the banking system is highly liquid on the back of growth in customer deposits. However, he says that local banks are challenged by “the scarcity of suitable lending opportunities within Kuwait and abroad”, and are still facing the effects of the slowdown in Kuwait’s commercial real estate and equity markets. In 2012 banks’ asset growth improved significantly and “we expect a continued improvement going forward”, he adds.

Credit growth increased to 5 per cent in 2012, the highest since 2009, according to the National Bank of Kuwait. But Kuwait’s business community has long blamed the slow pace of government spending for the stagnation of nonoil growth. The country recorded one of the highest fiscal surpluses in the world last year, approaching almost a third of its GDP, according to Citigroup estimates. But in Kuwait, the high surplus is a result of slower expenditure.

Like its Gulf neighbours, Kuwait has relied on a social contract between the ruling family and its citizens, providing a generous welfare system and creating jobs. However, since the onset of the Arab uprising Kuwaitis have taken to the streets to demand more accountability from the government and the ruling family. Lack of economic progress has been one of the major gripes of the opposition and the youth who look to countries such as the United Arab Emirates that have surged ahead with spending plans while Kuwait has stagnated.